Re: Cities to watch (good, neutral and BUBBLE?) - Posted by Robert Campbell
Posted by Robert Campbell on May 21, 2006 at 10:00:30:
John,
First let me thank you for the thoughtful response. I’m not an expert on Japan, but let me briefly comment on some of your statements.
>>> Lets ignore RE for a few minutes and compare the two economies.
>>> Culture. The culture between the two is pretty different when it comes to invention and conformity. The Japanese business culture respects authority and the idea that one should not rock the boat in the way that an American would do so. There is a lot of value placed on relationships and historical business connections.
RMC: True, but I don’t see what significance this has on the ups and downs of a free market economy.
>>> The Japanese banks competed for business with each other and measured the success based on size. Profitability and the pricing of risk were less interesting. Long term share cross holdings meant that a company was part of a family and there would be a lead bank in the group. Loans were approved based on relationships and not based on the ability of the borrower to service the debt from current operations. Defaults were rare and even when they happened it was the role of the bank to overlook the default through new financing or something similar.
RMC: Mortgage loans in the US have been based on exotic mortgage programs easy money lending, not the ability of a borrower to pay back the debt.
>>> Business climate. Japan is an island and the past was rather negative with WWII after shocks. There was a national focus on growth and success overseas. They are dependent on foreign oil for 100% of their needs. Becoming a global power was part of the agenda. The government supported national champions. The champions were directed into certain industries and the financing from the government and the banks was cheap. Other things I will not spend time are ‘jobs for life’, unemployment close to 1% considered normal, weak or little real social security, very high savings rates (30%), many/most jobs come with an annual bonus which tends to be saved, metro Tokyo average home size of 600 sq ft with a 2 hour one way commute - family of 4 in 600 sq ft.
RMC: I don’t see the connection between the inevitable booms and busts of a free market economy. Sorry.
>>> Educational system. The system is/was based on the German system from 1890. Conformity is important. The students are under pressure to perform. The kindergarden can define what companies you will interview with when you graduate from university. University is the first time a student is allowed to take their foot off the pedal. They use the 4 years to play a bit before entering the workforce.
RMC: See comment above.
>>> Stock market. While being the 2nd largest for a time the Japanese market was not that sophisticated in comparison. Even today the exchange can not handle large volumes. Back in the 1980’s a lot of shares were held by banks and friendly companies so the market liquidity was not that great. The average Japanese saves a great deal but that mostly goes into passbook savings with the post office or other investments so the investment culture is not that similar to the US.
RMC: I think you’re making way too much about nothing here, but thats my view. It was a classic asset bubble that burst, and history shows this is not uncommon in free market economies.
>>> I am not aware of the mortgage market details in Japan. Is there a secondary market? What is the average term of a mortgage in Japan. I do know that the scarcity of land is a very large factor. Japan’s usable land mass is 15% or something similar. That means that a country that has 2/3rds the population of the US has a usable land mass about the size of CA. Little opportunity to spread out so people are really stretched when buying a home. Similar to many CA buyers.
>>> I not sure I understand the connection between Japan and California. The common argument against real estate downcycles is that where there is a shortage of land, home prices can’t fall much. I think you and I both know the fallacy in this type of thinking.
>>> What about then vs. now if we only focus on the US.
>>> The mortgage market in the US has changed a lot. There are many more mortgage products that are not fixed. This has been going on over 30 or so years. ARMs were a new concept in the US when I took out my first ARM in 1982. There are now credit derivatives and other ways that lenders hedge their interest rate risk. Hence failure of the borrower to make the payments might be a lot less negative to the system then when there were more portfolio lenders. Credit derivatives are only about 5-7 years old.
RMC: I don’t care how you try to hedge risk, the risk is still there and someone has to bear it. Risk never disappears. Someone always ends up holding the bag.
>>> The Japanese stock exchange was over 40,000. I remember reading newsletters from some folks who just could not see how the values were justified as there was almost no dividend yield and very little expectation of growth in earning. The banks were the largest holders of shares and when the shares melted down the banks had liquidity issues. Hence they could not lend. No money to lend and both the borrowers and the property owners were in trouble. The US has a stock market melt down at the end of the dot.com era and the result was very different.
RMC: You’re overlooking something very big: market psychology, which is common to all markets. The study of economics is a social science, not physical science. I could write a books about this, but I know you understand my point.
>>> Some would argue that the Japanese response to the market was wrong. That the Bank of Japan should have used liquidity to bail things out. They waited too long and then had to set interest rates at zero for over 5 years to stem the deflation. The world view is not clear as people are still debating what could have been and what caused what.
RMC: With 20/20 hindsight, we all would have done things differently, wouldn’t we? In my view you are overestimating the control of Central Bankers and are underestimating the control of market psychology. As a sidenote, Alan Greenspan recogizes my last point very well.
>>> What does all of this mean?
>>> For the most part the issues that impact real estate are local in nature. A plant closing because GM is failing is much more likely to be an issue in a specific RE market than the US national economy. Dayton OH lead the nation in foreclosures last year (I am told). This was mostly because of plant closings related to auto suppliers. Other parts of the US were seeing rising prices.
>>> The biggest difference for why the US should not draw too many conclusions from Japan is because were operate very differently. The US believes less in central planning, has a different response to a stock market melt down, sees unemployment as less of an issue, banks attempt to price in the risk of default rather than chase market share, Silicon Valley mentality of eating your young rather than rock the boat in the corporate world, etc.
RMC: Again, you overlook that 800 pound gorilla - market psychology. History has a clear record on credit-driven asset bubbles - they all burst. No exceptions.
>>> There are definitely macro economics lessons to be learned from Japan. As I strongly believe that real estate value is defined locally the macro issues mean a lot less as you cross the Pacific.
Thanks again, John.
Robert Campbell